Eurozone Out of the Woods?
The gap between the core economies and the periphery is beginning to close, but challenges remain, says Morningstar's Jose Garcia Zarate.
Holly Cook: Hello and welcome to Morningstar. Today I’m going to be talking to Jose Garcia Zarate, he’s a senior analyst and economist with us here at Morningstar and he recently conducted some research into the health of the Eurozone and UK economies. Going forwards, we’ll be checking in with him on a quarterly basis to provide you with a macro and financial market overview on these markets.
Jose, thanks for joining me.
Jose Garcia Zarate: Thank you for having me.
Cook: So, we’re going to focus on the Eurozone now. Obviously the Eurozone has filled the headlines for, well, most of the last five years essentially…
Garcia Zarate: Yes.
Cook: …But it’s gone a little bit quiet recently and I suspect that maybe what’s underlying this is that things are looking a little bit better – and of course bad news sells doesn’t it – so is the Eurozone economy actually out of the woods?
Garcia Zarate: It has improved, I mean that’s for sure. We cannot talk about recession anymore; the Eurozone has been able to post four consecutive quarters of positive GDP growth. However, growth is very mild – it’s averaging just 0.2% on a quarter-to-quarter basis, that’s pretty sub-average.
Cook: And so within the Eurozone, obviously it’s not a homogenous region, do we continue to see quite a high level of differentiation between specific countries?
Garcia Zarate: The gap between the core economies – and in particularly Germany, which obviously is sort of the key strong economy in the area – and the periphery remains. However, on the plus side, it must be said that the peripheral economies are now also showing signs of positive growth. So the gap is actually closing, but the difference still remains in place.
Cook: So looking at the region as a whole, what would we say are some of the points of strength, what’s driving this marginal improvement?
Garcia Zarate: Well there’s been quite a substantial increase in external competitive particularly in the periphery, so that runs counter to the myth that the periphery couldn’t actually regain competitiveness within the Eurozone because of the straightjacket of the single currency. That actually is not true. Basically, some peripheral economies for example Spain and Portugal, and even Greece, have gone down the route of internal devaluation. That basically means pushing labour costs down in order to improve export competitiveness. And that has actually translated into a very swift readdressing of the very unbalanced current account deficits for these countries.
So the exports is the good bit of the recovery. However, domestic demand – not just in the periphery but actually in the eurozone as a whole – remains fairly depressed.
Cook: Ok, so what does that actually mean then for the economy as a whole – what steps need to happen to improve that?
Garcia Zarate: Well the thing is that you can only grow so much by exports. And at some stage you will need private consumption and investment to kick in, in order to sustain a recovery long term. And that’s actually the missing ingredient right now in the Eurozone, particularly in the periphery but not only the periphery – places like France for example suffer from high unemployment rates at the moment. There’s also the problem of a lack of availability of credit, particularly to small and medium enterprises (SMEs) and that’s basically neutering the investment drive within the area. So we need to see domestic demand being incentivised in some way.
Cook: So there’s some very positive news coming out of the periphery but there are also some key points that need to be improved.
Garcia Zarate: I think yes, there are some imbalances that have been corrected, but the unemployment situation is dramatic…
Cook: …60% youth unemployment in some countries…
Garcia Zarate: In some countries, yes, and that’s basically unsustainable. And it actually creates massive social and economic challenges for those countries. That’s why we need to get domestic demand started. I think a key factor is going to be the actions from the European Central Bank in order to restart the availability of credit, and in particularly – as I said earlier on – for the small and medium enterprises, because those are really the ones that generate the vast majority of the jobs in an economy.
Cook: Now of course we always want to know: what does this actually mean for the investors – for you and I who have our money invested in various stock markets? So what does this mean perhaps for an investor who’s based in the Eurozone, first off?
Garcia Zarate: Well the thing is that because of the actions that we expect from the European Central Bank, the expectation is that financial markets should be fairly well supported. For example, fixed income is a clear example; we’re not just talking about government bonds but also the corporate side of things. Monetary policy is very likely – well it’s not just likely it is going – to remain on a very accommodative stance for a protracted period of time. And that should provide some sort of support, very strong support to fixed income valuations for the time being.
But at the same time, that actually provides hopes that the economy might be doing better going forward and that should feed into the equity markets as well.
Cook: And does the story change for those investors based outside the Eurozone, such as those of us who are in the UK or even the US?
Garcia Zarate: I think the key question for non-eurozone investors is going to be the foreign exchange element. Because obviously the undeclared objective of all this action by the Central Bank is going to be to weaken the euro in a way, right? So if you are not a euro investor then you might want to factor in the potential for euro weakness relative to other traded currencies going forward.
Cook: Well it’ll be very interesting to check back with you in three months’ time and hopefully the situation will have improved further. Thanks very much for joining me.
Garcia Zarate: Thank you.
Cook: For Morningstar, I’m Holly Cook. Thanks for watching.